Stephen Bainbridge's Journal of Law, Religion, Politics, and Culture

04/11/2016

The Economist on the Panama Papers II: Regulate the Lawyers? How?

A leader in the latest Economist contends that one lesson of the Panama Papers is the need to "regulate the law firms and other intermediaries that set up and husband offshore companies and trusts. They are supposed to know their clients, weeding out the dodgy ones. But too many are paid to act as buffers, offering an extra layer of protection against those who pry."

Regulate the lawyers? How? Implicit in the Economist's argument is the notion that lawyers function as gatekeepers. What does that mean you ask? As I have explained before:

A gatekeeper is someone—be it a person or entity—who, if they withhold their blessing, can prevent the corporation from effecting a desired transaction or from maintaining some desired status.

Often, a gatekeeper will be a reputational intermediary who provides certification services for investors. Auditors and rating agencies are good examples of this category. They have a lot of reputational capital. Indeed, it must be so, because their reputation is their stock in trade. Investors say “this must be a good investment, because it got a good rating from an agency I trust.”

In theory, they will not besmirch their reputation to benefit one client. Hence, they hold the gate between the corporation and the promised land of investor capital. Without the blessing conferred by the auditor’s letter or the rating agency’s evaluation, the corporation will have a more difficult time selling securities or remaining listed on a securities exchange.

Lawyers also are corporate gatekeepers, albeit of a different sort. To be sure, sometimes a very high profile general counsel or law firm partner might be able to give a client in trouble the benefit of the lawyer’s reputation for probity and upstanding ethics. Usually, however, we play a more behind the scenes role.

But while we may not function as reputational intermediaries, we too have a gatekeeping role. As counsel, we are well positioned to block the effectiveness of a defective registration statement or prevent the consummation of a transaction.

Most lawyers hate the idea that they should function as gatekeepers:

The relationship between lawyers and clients is often intensely personal. Former SEC Chairman Harvey Pitt went so far as to compare the lawyer-client relationship to that between priest and penitent in the confessional. Lawyers are zealously supposed to guard, defend and promote the interests of their clients. To do that, Pitt argued, clients must feel comfortable confiding in their lawyers. Efforts to turn lawyers from advocates into gatekeepers can infringe upon the willingness of clients to confide in their lawyers, and curtail their ability to receive the benefits that flow from an unfettered lawyer-client dialogue.

In my view, however, that argument pertains mainly to the lawyer representing a client in litigation. A lawyer acting in a transactional of advisory role faces a different dynamic with different incentives and concerns.

The mindset advocated by Chairman Pitt leads to fiascos like Enron:

I’ll quote Enron examiner Batson, who observed that Enron’s “attorneys saw their role in very narrow terms, as an implementer, not a counselor. That is, rather than conscientiously raising known issues for further analysis by a more senior officer or the Enron Board or refusing to participate in transactions that raised such issues, these lawyers seemed to focus only on how to address a narrow question or simply to implement a decision (or document a transaction).”

So I am fine with the idea that attorneys should function as internal gatekeepers. And if that's what the Economist wants to encourage, great.

But there is a huge difference between lawyers taking steps within a firm to discourage client misconduct and forcing the lawyer to publicly blow the whistle on a client. If the Economist wants lawyers to become whistle blowers who call in the SEC cops, that really would trash the lawyer-client relationship. It would throw centuries of respecting client confidentiality out the window. It would destroy lawyer-client trust. To be sure, there are some cases where incurring those costs is worthwhile: Where the lawyer knows that the client is about to commit a serious crime involving a substantial risk of serious harm to life, limb, or property.

In general, however, the idea that we should broadly promote a role for lawyers as external gatekeepers strikes me as a very bad idea.